The Federal Reserve's interest rate cut could have a significant impact on global economic growth, influencing businesses and markets worldwide.
The Federal Reserve (Fed) cut half a percentage point from interest rates in September and signalled more to come. Will the move put wind beneath the wings of global economic growth?
After months of inaction, the Fed finally joined the monetary easing cycle in September with a 50 basis-point (bps) cut to interest rates.
While the move was widely anticipated, the size of the cut took some economists by surprise. US policy makers have been more cautious than counterparts in other advanced economies so far this year.
The Fed’s ‘jumbo’ cut brings it in line with the European Central Bank (ECB), which shaved half a percentage point off its key deposit rate with 25bps cuts in June and September. Both central banks hint at more to come by the end of the year.
Economists generally welcomed the Fed’s decision, which was prompted by declining inflation and weaker-than-expected employment data.
Cementing the downward trend of interest rates
The wider implication of the Fed’s decision to cut rates for the first time in four years is that the downward trajectory of global interest rates now seems to have taken off.
We expect further 25bps cuts in the US in November and December, as the bias of policy pivots towards protecting jobs. We predict further cuts of 25bps per quarter in 2025, bringing the rate to 3.25% - 3.5% by the end of next year.
As the world’s largest economy, what the US does matters. The Fed’s action signals that, after a long period of focus on inflation, policy makers are eyeing jobs and economic stability as well. By doing so, the Fed is indicating that it thinks the battle against sky high prices has finally been won.
While the central banks of advanced economies base interest rate decisions primarily on local and regional factors, the Fed’s decision cements the global direction of travel. The ECB is likely to aim for a deposit rate of 1.75% by the end of 2025, compared to 3.5% today. The Bank of England (BoE) will probably be more cautious, but rates could still fall to 3% in the same period.
More interesting right now is what happens in emerging markets. For central banks in much of Asia and Latin America, the US interest rate is an important benchmark. This Fed rate cut provides room for them to lower rates as well. If that happens is dependent on local circumstances as well.
That is even more true of the central banks of the Gulf Cooperation Council (GCC), many of whose members peg their currencies to the US dollar. Saudi Arabia, the UAE, Oman and Bahrain have already mirrored the Fed’s 50bps cut and will likely keep in step through 2024 and 2025. The Central Bank of Kuwait reduced its rate by 25bps.
The real world impact of rate cuts
Interest rate cuts are used as an economic stimulus. When rates come down, borrowing becomes cheaper for consumers as well as businesses. Consumers will be able to spend more on property and durable goods, and businesses more on investments. Confidence grows, the economy gets some tailwind.
But the impact of the rate cut should not be exaggerated. First, US rates remain well above pre-pandemic averages. Second, while the rate cuts take effect immediately, their effects will take some time to trickle through to the real economy. Interest rates are often fixed for a longer period.
For now, the real boost might come from the confidence that the prospect of sustained rate cuts produces in consumers, investors and business leaders. As consumers start to feel better about their economic prospects, they start contemplating big ticket purchases and even house moves. As businesses find it easier to attract finance, they invest in new equipment or plan new projects.
Commodities
Commodities could be one of the first sectors to benefit from the Fed’s decision. As the cost of capital declines, investment raise and the demand for raw material grows. Oil prices climbed in the week after the announcement, partly because of the hope that rate cuts would stimulate the global economy. Industrial metal prices also rose on the back of investor expectation of greater demand. Gold prices reached an all-time high and may go higher, as lower interest rates lure investors back into the luxury metals’ market. Even more importantly for economic development, this holds for share prices as well.
Retail
Retailers will hope that consumers with access to cheaper mortgages and car loans spend surplus cash in stores, especially on durables. In the wake of the Fed’s decision, credit companies quickly lowered the APR on several credit cards, and US mortgage rates were already falling in expectation of the Fed’s decision.
Manufacturing
When consumers start to spend again, manufacturers ramp up production, creating a domino effect through the supply chain. With lower interest rates, producers have access to cheaper finance, which allows them to invest in the equipment, technology and manpower to make goods more efficiently or create new product lines.
Logistics
As economies warm, the global flow of raw materials, components and finished goods accelerates. Logistics companies use growing order books to invest in new vehicles and technology. Business expenses fall when previous loans are refinanced at lower rates.
Reasons for caution
The Fed’s decision to begin cutting interest rates was widely anticipated and has been generally welcomed (though one group - savers - will be less enthusiastic). But the real benefits will only arrive when interest rates are a lot lower, and economists caution that there are some downside risks to that scenario.
“An escalation of conflict in the Middle East could further disrupt oil production and global supply chains,” adds Dana Bodnar, Economist at Atradius. “We are also facing a high-stakes US election in November. A win for Harris would signal continuity, while Trump has promised to impose major tariffs on imports, a move that could add to inflation risks and in turn keep interest rates higher for longer.”
Nevertheless, as things stand, we expect steady rate cuts in the US, Europe and much of the world through 2025. The wider hope is that the global economy has finally come to the end of a difficult cycle, heralding the return of serious and sustained growth.